There is no question that if any country has experienced unprecedented economic growth over the past two decades, it is China. Since 2008, at a time when global economies recorded one of their slowest paces of growth, the People’s Republic of China single-handedly spearheaded a global economic recovery one that is albeit weak but underway. The country has implemented sound policies which have not only launched its present growth trajectory, but has laid a solid foundation for years to come. One such policy is securing its energy supplies globally and its crude oil and gas in particular. The International Energy Agency has forecast that 65% of China's crude oil consumption will depend on imports by 2015. Currently, China's oil imports mainly come from the Middle East, Africa and Latin America with approximately half of these imports coming from the Middle East.

Shift in policyChina is the world’s second largest oil consumer and its second largest net importer of oil. In one of its major policy changes, China has increasingly started to look to diversify its crude oil and natural gas import basket to hedge against potential supply disruptions from its concentrated dependence on Middle East oil. China National Petroleum Corporation (CNPC), China Petroleum & Chemical Corporation (Sinopec) and China National Offshore Oil Corporation (CNOOC) are the major national oil giants that are responsible for securing the country’s energy supply. They have massive investments in Africa, Brazil and in Central Asia and usually have an advantage over other private oil companies with the development activities they offer supported by the Chinese government. Ranging from building infrastructure, providing loans for development and building refining and petrochemical complexes to the price they are willing to pay for rights to explore and buy assets in foreign nations have given China an advantage over would-be competitors in foreign markets. Not only do overseas investments provide a stable energy supply for China, they also help the government in maintaining and increasing its strategic influence across the globe. The Chinese government offers loans for E&P (Exploration & Production) activities and in return is guaranteed shipments of oil on an on-going basis. These loans have proven to be a decisive blow in many cases in successfully bidding on major oil contracts. A good example of its loan-for-oil strategy was the injection of billions of dollars into the Kazakh economy, through the Kazakh development Bank (KDB), in the year 2009 when the global economy was in shatters, making China the biggest investor in Kazakhstan and the most important contributor to Kazakhstan’s growth. No other country has matched the sheer scale of Chinese investment in this country so far.

Importance of the Commonwealth of Independent States (CIS countries)After the fall of the Soviet Union, 12 of the 15 former Soviet Republics joined the loose confederation of the Commonwealth of Independent States. Among its members are Kazakhstan, Kyrgyzstan, Uzbekistan, Tajikistan and Turkmenistan which hold varying degrees of oil, gas and other highly sought-after mineral resources. These states hold specific importance for China due to their close proximity to China, due to their abundant crude oil and natural gas resources or simply because their natural resources are pegged to develop at a rapid pace in the coming future.

The bar chart below shows the amount of reserves and current production projections these countries have.

In a major bid to increase their cooperation on a mutually beneficial basis, the government of China has signed several contracts with these countries to increase economic corporation and regional prosperity. One of the major sectors of cooperation has been in oil and energy. Statements have been made by the Chinese Premier Wen Jiabao from time to time stressing the importance China places on its relations with Central Asia. This has allowed, according to the China Daily, “Petro-China (CNPC) [to overtake] ExxonMobil Corp to become the world’s biggest oil producer when its annual crude oil production reached 886 million barrels last year, with the majority contributed by domestic production”. Impact of the Shanghai Cooperation Organization (SCO)Probably one of the most significant organizations for many [but not all] CIS nations and China is the Shanghai Cooperation Organization (SCO). It was officially founded by China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan joined in later as its 6th member to promote cooperation across almost every possible sector including in political affairs, trade, economics, transportation, energy and the list goes on. It is important to note that many of the major energy deals in the CIS including the construction of oil and gas pipelines, securing contracts for oil and gas supplies, provisions for technology transfer and exchange for building the same are increasing cooperation among SCO member states allowing them to effectively form an informal regional cartel for natural resource production and trade.

Going forward India, Iran, Pakistan, and Mongolia have been granted observer status in the SCO. If these countries decide to join as full members this could make the SCO the most important cooperation agreement in the eastern hemisphere. The SCO’s importance to China can be summed up in a single statement released by the Chinese Customs Administration in 2011; of the $16.98 billion in trade amongst the 5 Central Asian nations, Chinese exports to the region totaled $12.49 billion and imports to Xinjiang in Western China equaled $4.49 billion. This made China the biggest trade beneficiary amongst all SCO countries. At the same time it is pivotal for Central Asian SCO countries to redress their regional trade balances with China in order to successfully sustain the SCO as a viable multilateral organization for the benefit of all its members. China and Kazakhstan relationsKazakhstan is second only to the Russian Federation among CIS countries for proven oil reserves. Amongst Kazakhstan’s downstream customers, Italy is its largest Western importer with 25% followed by 16% of its oil sent to China (although this represents only a small portion of China’s oil pie). Chinese imports of Kazakh oil are expected to increase considerably in the future if only because Kazakhstan is landlocked and traditional marine transport is not possible.

Rail is used to deliver some Kazakh crude to export terminals on the Black Sea (Novorossiysk and Odessa) and directly to China. The most important mode of oil transport the country has is its pipeline network allowing its oil ultimately to reach urope and now China. The main pipeline serving China, runs from Kazakhstan’s Atyrau port in northwestern Kazakhstan to Alashankou in China's northwest Xinjiang region. This pipeline exported just over 200,000 barrels of oil (bbl) to China in 2010. The pipeline is a recent development having been jointly developed by the China National Petrochemical Corporation (CNPC) and KazMunaigas.

Further in 2010, gas from the transnational Turkmenistan–Uzbekistan–Kazakhstan–China pipeline was brought into operation delivering some 15.2 billion cubic meters (bcm) of gas to the Chinese economy. On a request from China, agreements have been reached to increase this gas pipeline’s capacity up to 55 bcm per year. As a step to deepen relations and goodwill, the Chinese government has signed an agreement to built a paraxylene complex with Kazakhstan. Paraxylene is the most important aromatic hydrocarbon today and an important feedstock for manufacturing fibers and plastics. Setting on developing this complex is a very significant move by China. First and foremost, it brings jobs and boosts the local economy of the region. Secondly, China is the largest consumer of paraxylene in the world with the country consuming 43% of paraxylene produced globally. This complex will protect against import shortfalls for the commodity and even allow China to expand on its current polymer production. Thirdly, the main feedstock for the manufacture of paraxylene is naphtha (a gasoline range hydrocarbon) which is produced by the distillation of crude oil and further processing of distillates produced during refining, thus providing a strong reason for setting up of a refinery in the near future. With so many advantages to both countries, it is easily overlooked that the major engineering and turnkey contracts running into millions of dollars for the development of these facilities mostly go to Chinese contractors, eventually resulting in huge profits and currency influxes to China.

Fourth, there is a tight demand and supply in the market for paraxylene with demand outstripping supply currently. Demand is further estimated to grow by 7.4% annually, historically the demand of paraxylene has grown exponentially from 1990 to 2012 and is expected to grow steadily till the year 2014. With almost all major production plants presently running at full capacity, there is a strong need for building new plants or revamping existing units. Thus, this project is an outstanding investment in terms of industrial development for Kazakhstan with direct benefit to China.

At the same time there is a public perception that Chinese companies employ their own people which does not benefit locals directly. In 2005 China bought Petrokazakhstan, that was the former Soviet Union's largest independent oil company, for $4.18 billion. Initially, Chinese investments were welcomed to counter-balance perceived US influence in the region and to allow Kazakhstan to diversify its trading partners away from dependence on Russia which historically has been the leading trading partner with the country; but with China holding more and more assets in the country, the influence of China over Kazakhstan is becoming an impediment. Earlier this year crude oil shipments hit a record-high of 5.95 million barrels per day. Chinese oil companies off-take is anywhere between 25-30% of Kazakhstan’s oil output. This is now considered a worrying trend because influence over such an important resource by a single country (China) is seen to threaten the autonomous decision making power of the country. With the Chinese nuclear sector in expansion mode, Kazakhstan has also recently signed an agreement to sell much needed uranium to China for nuclear power production (electricity) making China an even more strategic partner for some, but for others it makes Kazakhstan more and more dependent on China. Others believe that China is paying too heavy a price for the oil it needs but the fact of the matter is, it is China which needs to diversify its energy basket at home if it is going to keep on track in fulfilling its ambitions abroad.

Kazak crude is usually light sweet crude, generally blended with Russian Urals coming in from the Transneft pipeline from Russia and with other feedstocks such as Azeri light crude. Such crude is in high demand as it contains less sulfur and is much easier to refine requiring a lesser Nelson’s Refinery Complexity Index. (The lower the number of the index the simpler is refining in terms of technology required and the number of processing units required.) The Chinese domestic crude blend is of a similar nature. Importing these blends could provide a substitute for Chinese domestic crude.

China and TurkmenistanTurkmenistan's natural gas reserves are the fourth largest in the world, and is considered as the region’s gas giant, behind Russia, Iran and Qatar. Just like all former Soviet nations’ lack of foreign investment, Turkmenistan is no different. Russia has been its primary export market but Iran and China are coming on stream at a very rapid pace. The country is on the lookout for investments to develop its gas resources. So instead of looking West it has looked East towards China. The China Development Bank provided a $4 billion loan in 2009 for a Central Asia-China gas pipeline project's first phase of development, and in 2011 pledged another $4.1 billion for the second phase. Industry analysts expect the declines in the Turkmen fields of Amu Darya basin, Murgab Basin and the South Caspian basin to be offset by one of the largest new reserves of gas in South Yolotan in eastern Turkmenistan to be online by 2013. In mid-2011, CNPC announced the pipeline's capacity could rise to over 59.43 bcm/year by 2015.)

With China looking to triple its share of natural gas in its energy mix by the end of the decade, Turkmenistan could play a vital role in achieving this objective. The inter-governmental gas supply deal between China and Turkmenistan includes the 35-year Bagtyyarlyk production sharing agreement, providing 13.02 bcm/year with 17 bcm/year to come from Turkmenistan's other southeastern gas fields such as South Yolotan. The pipeline is referred to a “source of prosperity for the region” as suggested by leaders of both countries. Just as the case with Kazakhstan, Chinese companies face an image problem in Turkmenistan with one of the Chinese officials Zhou according to the Chinese Daily even suggesting that “Chinese enterprises should work hard in improving company image, safeguarding national reputation and lifting the credibility of Chinese companies, asking the Chinese employees to obey the Turkmen laws and respect local customs and traditions.” This is one of the strongest statements which has come from China in recent years. China recognizes that failure to improve on providing local benefits to its trading partners could result in a serious barrier to future foreign investment if it doesn't change its behavior in the short-to-medium term future.

China and UzbekistanUzbekistan holds an estimated 1.84 trillion cubic meters of proven natural gas reserves. Russia’s Lukoil has significant investments in the country and has plans to export gas to China. China and Uzbekistan signed an agreement in June 2012 to sell an annual 10 bcm of Uzbek natural gas to China. Uzbekistan is also a transit country for Turkmenistan's gas exports to Russia and China. At the same time, China’s Eximbank agreed to provide $74 million to modernize Uzbekistan's gas distribution network to facilitate the flows to China. CNPC established the Sino-Turkmenistan Gas Pipe Corporation to construct a 1,140-mile gas export pipeline from Turkmenistan's eastern fields through Uzbekistan to western China and the interconnection with China's West-East pipeline . Turkmenistan is designed to be the key contributor of gas to China through this pipeline, but after Uzbekistan country finalized a gas supply deal with China at the end of 2011, it started exporting its own gas earlier this year. The agreement with Beijing allows the ex-Soviet republic to break away from Moscow’s orbit of influence. Uzbekistan is fully aware of the cost of dependency on Russia when it refused to buy gas from Turkmenistan, contributing to an economic crisis in that country; hence Uzbekistan is seeking to increase its cooperation with China and other countries looking to tap into its vast energy resources.

The India angle After China, the fastest growing country and the most important market in Asia is India. Just by the virtue of its location and its population, India is a natural competitor for natural resources with China. India will require huge quantities of oil and natural gas to support its expanding industrial production. At present, India is the sixth largest energy consumer in the world. Early in 2012, Turkmenistan finally agreed to the construction of the Turkmenistan-Afghanistan-Pakistan-India or TAPI gas pipeline but despite support from both the US government and the Asian Development Bank for the project the pipeline remains mired in inertia.

Overall the Indian energy giant Oil and Natural Gas Videsh Limited (OVL) has had stiff completion with the Chinese NOCs (Nationalized Oil Companies) in recent years over winning foreign tenders; most have been won by China due to at least in part to India’s debilitating bureaucratic ineptitude. China nevertheless cannot downplay India as a competitor and in certain instances the two have bid together to compete successfully against third parties.

Importance for ChinaChina’s competitive advantage in securing oil and gas contracts with foreign states and companies, over their western independently owned counterparts, has been in providing loans through Chinese banks for providing infrastructure where hydrocarbons’ development is to occur. This has time and again given a lethal blow to non Chinese entities vying for the same resources.

As mentioned earlier, China seeks to substantially increase its share of natural gas in its energy mix by the end of the decade. However in order to do so, it not only needs the support of these nations but at the same time needs to develop its own coal resources to convert this coal to gas. Already, there are many technologies available in the market to convert coal to natural gas and China has already successfully tested them in pilot plants. But it remains to be seen how soon these plants come on stream to satisfy China’s ever increasing energy demand. As an aside, China is now the world’s largest greenhouse gas emitter and there is considerable pressure being lead by international institutions to persuade China to reduce these emissions significantly. If the country has any ambitions to adhere to international protocols, natural gas may be China’s best bet.

In conclusion, Central Asia’s need for foreign investment couldn’t have come at a better time at least for China. China has massive currency reserves that require investment somewhere. Therefore its ability to fund infrastructure development in return for guaranteed oil and gas shipments bodes well domestically as well as for its international partners and partner countries. While Chinese investments in oil, gas, rail and road infrastructure will help boost the economic performance of countries in Central Asia (and in doing so raise their international profile), the fact of the matter is that Central Asian republics actually have few alternatives to China for foreign investment in the present economic climate.

Contributor Aditya Malhotra is a Field Service Adviser at UOP India Private Ltd.,A Honeywell Company and the views expressed in this article are exclusively those of the author

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